The U.S. Securities and Exchange Commission recently eliminated a long-standing rule prohibiting hedge funds from advertising to the general public—a move critics say is a blow to investor protection. But it’s only a risk if you happen to be rich and foolish.

Most unsophisticated investors wouldn’t be able to place their money with a hedge fund anyway, given SEC requirements that a person have at least $1 million in assets (not including a house) or income of at least $200,000 in each of the past two years to be eligible to invest.

And those who do qualify should know better: Several studies have shown that hedge funds, which can use more risky trading strategies to try to earn big returns, have collectively underperformed the stock market over the past decade. For one thing, the industry charges investors massive fees, known as “two and 20,” or a two per cent flat fee on the assets invested and 20 per cent of the returns. That’s a high mountain to climb before profits are realized. Moreover, it’s hugely difficult for a hedge-fund manager—any hedge-fund manager—to consistently outperform the market by a wide margin, given that every winning trade necessitates that someone else has made a losing one. Of course, that’s unlikely to appear in any advertisements.

When a company reports a 45 per cent drop in profit for the quarter, what does its stock price do? If it’s Amazon, it soars. On Jan. 29, a day after the online shopping behemoth released its disappointing fourth-quarter results, its stock went up nearly 10 per cent to $284, pennies shy of the record hit earlier last month. “Have investors gone insane?” asked Henry Blodget, on the financial blog the Daily Ticker. A Forbes article called those who rushed to buy “mad hatters” and dubbed the whole situation “Amazon in Wonderland.”

So what explains it? The answer can be found partly in the company’s growing sales, up 22 per cent in the quarter, to $21 billion. Along with sales of consumer goods—from books and televisions to diapers and toys—revenue is growing from Amazon’s cloud computing system (used by tech companies like Netflix and Dropbox). Its Kindle brand, meanwhile, has helped the company increase ebooks sales by 70 per cent last year. And Amazon continues to grow its tablet line (the Kindle Fire is the latest) to compete with the likes of Apple and Samsung. There are rumours the company is eyeing the smartphone business, too.

Amazon’s chief problem is that its low prices and free shipping strategy ensure that its profit margin is miniscule. (Amazon actually lost $39 million in 2012.) But there is lots of room for growth and signs of improvement. Gross margin increased by four per cent last quarter over the same period last year. The company is also investing heavily in new shipping centres, which could further boost profitability. Victor Anthony, an Internet analyst with Topeka Capital Markets, says Amazon’s stock is actually undervalued.

Consider, by comparison, the fate of Apple. The iPhone maker also released quarterly results last month. It had record profits of $13 billion, but a shrinking gross margin, down six per cent from the same period last year. As a result, investors lost faith and its stock took a hit, dropping by about the same amount (10 per cent) that Amazon’s stock went up.

Andrew Hepburn is a former hedge fund researcher. He writes on commodities, the stock market and the financial industry–but without the jargon.

Once again, food prices are soaring. For the third time in five years, the world seems on the verge of a crisis. Prices for corn, soybeans and wheat have all skyrocketed on international markets, rising 21 per cent, 41 per cent and 31 per cent respectively since the start of the year.

The key question is: Why?

The standard answer is that there are a plethora of factors making food more expensive worldwide. The International Monetary Fund lists them in the following order, which is fairly typical:

• Strong food demand from emerging economies, reflecting stronger per capita income growth, accounts for much of the increase in consumption. Although demand growth has been high for some time now, the recent sustained period of high global growth contributed to depleting global inventories, particularly of grains.

• Rising biofuel production adds to the demand for corn and rapeseeds oil, in particular, spilling over to other foods through demand and crop substitution effects. Almost half the increase in consumption of major food crops in 2007 was related to biofuels, mostly because of corn-based ethanol production in the US; and the new biofuel mandates in the US and the EU that favor domestic production will continue to put pressure on prices.

(…)

• The policy responses in some countries are exacerbating the problem: (i) Some major exporting countries have introduced export taxes, export bans, or other restrictions on exports of agricultural products. (ii) Some importing countries are not allowing full pass-through of international prices into domestic prices (less than half a sample of 43 developing and emerging market countries allowed for full pass through in 2007).

• Drought conditions in major wheat-producing countries (e.g., Australia and Ukraine), higher input costs (animal feed, energy, and fertilizer), and restrictive trade policies in major net exporters of key food staples such as rice have also contributed.

• Financial factors: the depreciating US$ increases purchasing power of commodity users outside of the dollar area; falling policy interest rates in some major currencies reduce inventory holding costs and induce shifts from money market instruments to higher-yielding assets such as commodity-indexed funds.

As a former hedge fund analyst, I am regularly perplexed to see the role of financial markets mentioned last, almost as a footnote. On more than one occasion, I encountered large global investment banks that publicly claimed high prices were the result of supply and demand, but privately conceded that financial bets or manipulation were, in fact, the dominant influence. A classic example is what happened in September 2008, when JP Morgan’s head of commodity research told Congress that oil prices had soared due to supply and demand, while on the same day the bank’s chief investment strategist wrote in an email to wealthy clients that “there was an enormous amount of speculation pent up in energy markets . . . and it wasn’t just the supply-demand equation.”

Now, there is no question the drought in the U.S. Midwest played a role in this year’s dramatic increase. But neither the weather nor supply and demand explain very well why prices climbed so suddenly and steeply last summer:

As the chart above shows, the price of wheat took off in July, when news of the drought started circulating. But it is highly unlikely that it was end buyers concerned about a supply shortage who caused that hike. If we look at wheat inventories as a percentage of global consumption, in fact, stocks are low, but not dangerously so—and they have been declining for a few years:

The fingerprints of speculators are all over this. According to the Wall Street Journal, “Hedge funds, pension funds and other noncommercial investors have ramped up bets on rising wheat prices to the highest level on record, as of Sept. 4, according to Commodity Futures Trading Commission data back to 2006.”

“…there are increasing signs of instability, illiquidity, volatility, and price dislocation, all attributable to the speculative or financial participants, rather than the core commodity participants. Since the size of traded commodity markets remain much smaller than that of other financial markets, any marginal increase in commodities investment by market participants… has a disproportional impact on prices.”

In one colourful example, the BOC went on to discuss the case of the cocoa market in mid-2010, where one hedge fund apparently purchased a futures market position “equivalent to 5.3 bln quarter pound chocolate bars,” helping to propel the price of cocoa to its highest level in 33 years. The fund subsequently took physical delivery of the 240,000 tonnes of chocolate—equal to 15 per cent of world inventories—earning the manager who ordered the purchase the nickname “Choc Finger.” The episode sparked concern that speculators were cornering the markets for food commodities.

Excessive speculation over chocolate bars might make us chuckle, but the real concern is that financial players are causing untold human misery by pushing the prices of staples such as wheat and corn to rise to unjustified levels. This is most true in the developing world, where the poorest often spend 50 to 80 per cent of their incomes on food.

As I’ve written before, speculators have herded into commodities based on the assumption that increased demand from emerging economies will drive up the price of anything from copper to corn. But there’s one another very big reason financial players these days buy commodities: central bank stimulus measures. Over the summer, investors increasingly came to expected the Federal Reserve to introduce another round of so-called quantitative easing, in effect the printing of new money, to stimulate the economy (something that the Fed, it in fact, announced it would do this week). Sensing this, investors rushed to pour money into commodities, which they perceive to be “hard assets” largely to hold their value during any future inflation. So even though the “BRIC” countries are notably slowing, commodity prices are on the rise again.

The BOC memo alludes to this as well, noting that “Investors argue that commodity purchases are justified as a hedge against inflation and a hedge against a weak dollar since most commodities are priced in dollars.” This mentality is perhaps the greatest unintended consequence of recent central bank stimulus: the more they intervene, the greater the desire of financial markets to bet on vital commodities like food and oil.

The next time you read that weather in some corner of the world is causing food prices to surge, keep in mind that a torrent of money is likely exacerbating the rise in prices. Wall Street, after all, deals in stories. And the stories that contain some truth can be the most profitable.

There’s a good reason for investors to pay extra close attention to those quarterly-earnings conference calls. Researchers at Stanford University have developed a model that can help determine when company executives are lying. By studying the question and answer section of conference calls from firms that later substantially restated their earnings, researchers uncovered some tell-tale cues of deceitful behavior.

When lying, CEOs tend to speak with less hesitation (because they have more prepared answers or are answering planted questions), avoid using the word “I” and use more words expressing extreme emotion, like “fantastic.” They also avoid the phrase “shareholder value” and swear words. Lying CFOs, on the other hand, speak much more tentatively and avoid words that express extreme emotion. Both CFOs and CEOs share one trait: they often use phrases that reference general knowledge, like “you know.” So now, you know what they’re really saying.

Vito Maida is arguably the most stubborn money manager on Bay Street, and he has paid dearly for it. A decade ago, when he was lead Canadian portfolio manager at mutual fund giant Trimark Financial Corp., he insisted soaring Canadian bank stocks were overvalued and stayed away from then-hot Nortel Networks. Instead, he invested in unpopular commodity stocks and gold. Investment advisers called for his head and pulled their clients’ money from his funds, and he was fired. Then the Internet bubble burst, Nortel crashed and commodities soared in value.

So Maida started his own money management firm, Patient Capital Management, based on the premise you should never, ever lose your clients’ money. For more than eight years, he kept 80 per cent of assets in government treasury bills, holding steady to the belief everything else was overvalued. As the TSX posted double-digit returns from 2004 through 2007, Maida earned between three per cent and seven per cent a year. Business was depressingly slow. “It was tough to sell a product that was 80 per cent cash,” Maida says. Today, Patient manages under $100 million, a pittance in the wealth management business. “We’d like to be bigger, quite frankly.”

He may yet get his wish. Investors who were patient with Patient are among the biggest winners in the worst market crash since the Great Depression: last year the TSX fell by a third; Maida earned a 4.5 per cent return. As markets cratered last fall, Maida finally began to plow much of his cash into stocks. “He’s one of the best pure investors I have ever known,” says friend and former Trimark colleague Keith Graham. “His timing is not always [perfect] but he sees big changes earlier and clearer than anyone I’ve ever met.”

Maida’s past newsletters to Patient investors reveal a deeply skeptical and prescient investor. For years he cautioned that assets of all types were expensive; in March 2004 he warned of a housing bubble and foretold “history will judge [then-U.S. Federal Reserve chairman Alan] Greenspan harshly” for keeping interest rates low for too long. It was a lonely opinion at the time, but not anymore. Months before the credit crisis began in 2007, he wrote: “The absence of fear and complacency toward risk truly astounds us.”

“He’s had a very bleak view of the future the last several years and it paid off big time in his results,” says Bob Krembil, Trimark’s co-founder and former CEO, who fired Maida but has remained close to him since. “You have to be wrong in the short term to be right in the long term,” Maida says of his style, known in investing circles as “deep value” and employed by famed investor Warren Buffett and Maida’s former boss, legendary Bay Street investor Prem Watsa. “And the short term can last several years.”

Maida, the son of Italian immigrants, grew up poor in Toronto’s west end; he was that kid who owned just two pairs of pants. His father was a construction worker, and when his mother was sick, the family relied on help from social welfare agencies. “Not being well off instilled in me the value of a dollar,” he says. “That’s really the crux of the whole adherence to value investing: don’t lose money, because money is really hard to come by.”

Maida’s other defining experience was the crash of October 1987. It happened five months after the newly minted M.B.A. began as a fund manager with the Ontario pension plan OMERS. The experience of watching his stocks collapse scarred him. “I never wanted to be in the position where I’d lose people this money,” he says.

Maida has lived up to that promise thus far, but building his business has been harder. Like other fund managers who strike out on their own, he has struggled to compete against the industry giants that have the scale, distribution and sales forces to reach and keep investors. “It’s a slow process, and gathering assets is a lot harder than I would have thought,” says Maida (Patient’s investors must also pony up a minimum $500,000). In a major setback last fall, more than half of Patient’s business vanished when an intermediary that had invested in Patient on behalf of a large institution had to pull out.

The other problem is Maida himself. He is the first to admit he’s a “terrible salesman, a terrible networker. I’m not very comfortable in social situations.” Graham describes the six-foot, heavy-set Maida as a “frumpled, crumpled curmudgeon. He’s more focused on investing the money than he is on getting more money.” Patient managed to raise $10 million in 2008 despite the fact Maida still hasn’t replaced his former head of sales, who left a year ago.

But to his loyal, if select, customers, Maida’s dishevelled appearance doesn’t matter. “He probably sells himself short,” says Matt Stewart, a Toronto-based client who has invested his mother’s savings with Patient. “It’s this kind of humility that comes with the disposition you need to be a great value investor. I can sleep very well at night knowing Vito Maida is managing my mother’s money.”

After a decade in the professional wilderness, Maida is sleeping well these days too.

As markets continue to fall, analysts have simply started using historical dates to forecast how low we could go. Today Montreal-based BCA Research warned that U.S. equities could fall to levels not seen since 2002. As it is, the last time the S&P 500 was this low was in April 2003:

Panic has returned in full force: equity and commodity prices are gaping lower, while the dollar and yen continue to surge. Investor sentiment has been crushed and despite extremely oversold conditions and appealing valuations, the bleak growth outlook provides little reason to be upbeat.

That’s gloomy enough. But it gets worse. The lows of 2002 followed the mania of the dot-com bubble and its collapse. The fact is, we’ve already been there before. Back in 1997. In other words, if you bought an S&P 500 index fund 11 years, 4 months and 13 days ago, prior to the Dot-Com bubble, and then the debt-fueled bubble, the only gains you would have received over that time would have come from dividends.

(click to enlarge)

Granted, that’s an overly simplistic way to look at investing. Few people ever take a lump sum and dump it into an index fund on any single day. They spread their investments out over time and benefit from dollar-cost averaging. But as my colleague Steve Maich points out in his latest column in the magazine, stock markets don’t always go up over time. He used Japan’s Nikkei index, which has mostly headed south for the last two decades, as the example. But this latest rout shows that even in the West markets can be a huge let down for long-term investors.